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Real Estate's Quarter Turns to Quicksand

Editor's note: As a special feature for April, is offering a series reviewing the first-quarter performance of mutual funds and ETFs. This is the sixth installment.

If there is one thing Superman's arch villain Lex Luthor obsesses about more than the man of steel, it's real estate. In the 1978 Superman movie, Luthor attempted to turn his worthless inland California plots into rich beachfront property by blowing up the coast.

That's a bit extreme, but the point is that world population is growing, everyone needs a place to call home, and land is a limited commodity.

Add to that the worldwide sourcing of goods in an expanding world economy and it is not surprising that nine of the top 10 performers for the first quarter specify either an international or a global focus for their selection of real estate investments.

Here in the U.S., the big story in real estate this quarter was the homebuilders. New-home sales plummeted 15.8% from December to January and another 3.9% in February, according to the U.S. Department of Commerce.

Sales of existing homes have held up pretty well due to sellers' willingness to drop their prices. Since its peak in July 2006, the median U.S. home price has fallen 7.6%. This undercuts the efforts of new-home builders to sell their stock of homes and limits new-home building projects.

Combining the superior global returns with the dreadful performance of the U.S. homebuilders and other domestic funds resulted in an average total return of 2.02% for the first quarter for the real estate funds we track.

(RIT) LMP Real Estate Income Fund (RIT) and (JIRAX) JPMorgan International Realty Fund (JIRAX) had extraordinary first quarter total returns of 16.23% and 9.31%, respectively.

(EIIPX) EII International Property Fund (EIIPX) scored big with a return of 8.24% by investing in countries outside the U.S., including 26.6% U.K., 16.5% Hong Kong, 12.6% France, 12.1% Japan and 10.0% Italy. The assets were allocated to 63.8% real estate, 26.8% REITs, 4.9% lodging and 2.6% homebuilders.

Top-Performing Real Estate Funds
Fund Ticker Rating Fund Type Q1 Total Return
LMP Real Estate Income Fund Inc RIT B Closed-End 16.23%
JPMorgan International Realty Fund JIRAX U Open-End 9.31%
EII International Property Fund EIIPX U Open-End 8.24%
Alpine International Real Estate Equity Fund EGLRX A+ Open-End 7.76%
Morgan Stanley Inst Global Real Estate Portfolio MRLAX U Open-End 7.70%
SPDR DJ Wilshire International Real Estate ETF RWX U ETF 7.40%
Dryden Global Real Estate Fund PURAX B+ Open-End 7.18%
Cohen & Steers International Realty Fund IRFAX U Open-End 6.87%
AIM Global Real Estate Fund AGREX U Open-End 6.13%
ING Global Real Estate Portfolio IRGIX U Open-End 5.66%
Source: Bloomberg

It seems everybody knows somebody in a real estate bind. Some struggle to keep up with mortgage payments or are already in foreclosure. Others have been laid off from construction work.

Earlier this month, a friend of mine was one of many to lose her job in a mass layoff at one of the homebuilders held by iShares Dow Jones US Home Construction Index Fund (ITB). The fund lost nearly one-fifth of its value, dropping 19.25% for the quarter.

iShares Dow Jones U.S. Home Construction Woes*
Homebuilder (Ticker) Q1 Return Rating Fund Type Q1 Total Return
Technical Olympic USA Inc (TOA) -60.77% B Closed-End 16.23%
Beazer Homes USA Inc (BZH) -38.07% U Open-End 9.31%
Meritage Homes Corp (MTH) -32.69% U Open-End 8.24%
M/I Homes Inc (MHO) -30.42% A+ Open-End 7.76%
Hovnanian Enterprises Inc (HOV) -25.78% U Open-End 7.70%
Centex Corp (CTX) -25.69% U ETF 7.40%
Levitt Corp (LEV) -23.83% B+ Open-End 7.18%
Ryland Group Inc (RYL) -22.58% U Open-End 6.13%
Standard-Pacific Corp (SPF) -21.99% U Open-End 5.66%
Pulte Homes Inc (PHM) -20.00% B+ Open-End 5.61%
*Stocks held by iShares Dow Jones U.S Home Construction losing 20% or more for the first quarter of 2007
Source: Bloomberg

As long as potential homebuyers wait on the sideline for home prices to fall further, the U.S. real estate recession will continue.

With only a 1.2% asset association to homebuilders and 89.2% in REITs, the (IIA) ING Clarion Real Estate Income Fund (IIA) gave back 9.12% in the first quarter. One of IIA's holdings, Maguire Properties (MPG), a California office REIT, was off 10.1%.

The company is directly feeling the impact of the subprime market crisis by having New Century as a major tenant.

Worst-Performing Real Estate Funds
Fund Ticker Rating Fund Type Q1 Total Return
iShares DJ US Home Construction Index Fund ITB U ETF -19.25%
SPDR S&P Homebuilders ETF XHB E- ETF -12.71%
ING Clarion Real Estate Income Fund IIA B Closed-End -9.12%
RMR Preferred Dividend Fund RDR E Closed-End -8.73%
Cohen & Steers Advantage Income Realty Fund Inc RLF B Closed-End -6.44%
Fidelity Select Home Finance Portfolio FSVLX E- Open-End -6.19%
Cohen & Steers Worldwide Realty Income Fund Inc RWF B Closed-End -4.74%
Cohen & Steers Total Return Realty Fund Inc RFI C Closed-End -4.39%
Nuveen Real Estate Income Fund JRS B Closed-End -3.68%
Cohen & Steers Premium Income Realty Fund Inc RPF B Closed-End -3.49%
Source: Bloomberg

As with any area of investment, diversifying within and among sectors helps minimize risk. Take a look at your real estate holdings to be sure that they are not concentrated in any one geographic market. Balance domestic with international and homebuilders with office and residential REITs.

The U.S. real estate tremors may continue to shake well into 2008, but that does not mean the area should be avoided. Be on the lookout for real estate bargains created by well financed REITs cashing out distressed sellers.

Note: The author holds the Alpine International Real Estate Equity Fund in a retirement account.

Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.

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